Reactions to the Romney Tax Returns

Ed note: If you received an email earlier today, please disregard. I had a case of premature publication. It’s embarassing, but it happens, and I’m not ashamed to admit it.

In response to increased scrutiny regarding the effective tax rate paid on his substantial income, Republican Presidential candidate Mitt Romney released his tax returns late last night. Yours truly was given an opportunity to review the returns immediately upon their release for Bloomberg and provide comment. You can read that article here, but in the interest of keeping this blog self-contained, the most revealing items included in Romney’s 2010 individual tax return are discussed below:

His real name is Willard? I’d go with Mitt, too.

Romney paid $3,000,000 of federal tax on $21,600,000 of gross income, for an effective rate of 13.9%. While this is sure to draw ire from the 99-percenters, it is 100% legal, and is largely attributable to two things:

Romney’s $18,000,000 of alternative minimum taxable income (he paid a small amount of AMT) consisted of $15,500,000 of income eligible for the preferential tax rate of 15%. In specific, $3.3M of Romney’s $4.7M of dividend income was eligible to be taxed at this lower rate, a break that was added to the Code with the Bush tax cuts. In the absence of the Bush legislation, Romney’s entire $4.7M of dividends would have been taxed at the maximum ordinary income rate, currently 35%. In addition, Romney’s also recognized $12.2M of long-term capital gains, which similarly benefitted from the Bush cuts. The gains are currently taxed at 15% rather than the 25 or 28 percent rates that existed previously.

As expected, Romney benefits greatly from the current treatment of “carried interest” as provided for under administrative rulings issued by the IRS. In short, a carried interest is a partnership interest granted to a partner — typically a money manager in a private equity firm — in only the future profits of the partnership in exchange for managing the money of the private equity firm, choosing its investments, divestitures, etc… Under Rev. Procs. 93-27 and 2001-43, the granting of a pure profits interest is not a taxable event; thus, when Romney receives a profits interest in a private equity firm, it is not taxed as compensation (or capital gain), and the future income of the private equity partnership that is allocated to him — typically long-term capital gains — is eligible for the preferential 15% rates.

The reason carried interests have come under attack — particularly from the Obama administration — is obvious. On the surface, the amounts allocated to the managing partner certainly appear to be compensation for services; thus, according to critics, they should be taxed at ordinary income rates rather than capital gain. While this law may change in the future, it is important to note that Romney is completely correct in treating the amount of income allocated to him from his carried interests — $7,000,000 of the total $12,200,000 of capital gain according to his campaign — as LTCG rather than compensation.

Of Romney’s $3,000,000 of charitable contributions, half were made in cash to the Church of Latter Day Saints (which would appear to be part of Romney’s tithing requirement), and half made in stock to Romney’s private foundation, the Tyler Foundation.

How bad were things in 2009 if even Mitt Romney had a $4,000,000 capital loss carryforward to 2010?

All in all, there as nothing shocking about Romney’s tax returns. Yes he paid only 13.7% of his income to the IRS in federal tax, but such is life under the current tax regime when the overwhelming majority of your income is earned in the form of long-term capital gains and qualified dividends. Critics, however, are sure to focus on four things:

The effective rate. Again, for right or wrong, Romney paid only 13.7% of his income in tax, but he did so legally and in total compliance with the current rules.

The pure size of the numbers. Even for a Presidential candidate, $20M of AGI is a lof to income, which may not be particularly well received in this time of the Occupy Wall Street movement, cries of economic inequality, and other opening salvos of class warfare.

Romney received a $1.6M tax refund in 2010. Now you and I know that tax refunds are purely a function of your tax liability compared to the estimated payments you’ve made, but the public is likely to find it hard to swallow that someone with $20M of income received a refund exponentially larger than most people’s income for the year. Again, it’s not the right reaction, but it’s likely to occur.

Prior to the release of his returns, Romney admitted to a 15% effective rate, stating that he did generate some ordinary income from speaking fees, but “not much.” It turns out “not much” was in excess of $500,000, a sum most would be more than happy to accept for a few hours of speaking. This could position Romney as “out of touch” with the average American, an angle many of his critics and opponents may embrace.

10 Responses

Overall an informative post, thank. But I’d take issue with the above. What is the “right reaction”? You can agree or disagree that our current tax regime is appropriate, but whichever side you’re on, Romney’s taxes–while “legal”–certainly throw the question into stark relief.

Given that Romney is a full-throated supporter of the status quo, I’m not sure a negative reaction to these numbers by your average voter is “right” or “wrong”.

Allow me to clarify. I don’t believe it is the “right reaction” to focus on his refund becasue his refund is solely a funciton of his tax liability versus his estimated tax payments. Had he felt the need to make an addiitional $1,000,000 of estimated payments, his refund would have been $1,000,000 larger, but his tax liability and effective rate would be the same. People are certainly free to have whatever innate reaction rises up within them when they see Romney’s tax return, I just think the fact that he got a “refund” is in itself immaterial. Looking at it the other way, if he failed to make ANY estimated payments, he would have owed $3,000,000 with this return, but that doesn’t make his tax rate any more right or wrong.

Of course his effective tax rate for 2010 was actually 17.6%. Why is it being falsely reported as 13.9%? Total Income or Adjusted Gross Income is never a factor in the computation of either effective or marginal tax rates. If the media is going to remove his itemized deductions and then compare that to those paying 15% on modest wages, then they also need to take away those standard deductions and personal exemptions to compare apples to apples.

Furthermore, Romney’s $4M in dividends have already been taxed, likely at 35%. So some of his income was actually taxed at 50%.

The bottomline is the media doesn’t know enough to even report a story like this. And by media I’m specifically referring to all the major networks who have misreported this information.

And no, I don’t plan to vote for Romney, but based on truths and facts not misinformation.

Erick, you make a wonderful point about the fact that many of Romney’s investments are in corporate form (i.e., the stock that produced dividends and capital gain). Thus, you can’t really call his effective rate 13.9% because as you point out, much of the income his investments have earned have already been taxed at the corporate level at rates as high as 35%. This is a point I brought up in my interview with Bloomberg, and while many tax savvy people are aware of the dangers of labeling Romney’s rate as a pure 13.9%, let’s face it: 13.9% makes for a a much more attractive headline.

[…] who upon making public his tax returns in January, revealed that he paid an effective tax rate of a mere 13.9% on $21,600,000 in adjusted gross income. Now granted, Obama first announced his plans for a Buffett Rule in August of 2011, months before […]

[…] party portraying Romney vast wealth as leaving him out of touch with the common man, and the 13.9% tax rate he paid on $20 million of income in 2010 as the symbol of all that’s wrong with our current […]

The items in this blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation. A select group of Tax Professionals of WithumSmith+Brown write Double Taxation, and any opinions expressed or implied are not necessarily shared by anyone else at WithumSmith+Brown.

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